Bankruptcy Reform

National Association of Federal Credit Unions

P.O. Box 3769

Washington, D.C. 20007

(703) 522-4770

Introduction

The National Association of Federal Credit Unions (NAFCU) is the only national organization exclusively representing the interests of the nation's federally chartered credit unions. NAFCU is comprised of more than 1,060 federal credit unions--financial cooperatives from across the nation--that collectively hold approximately 70 percent of total federal credit union assets; NAFCU represents the interests of approximately 25 million individual credit union members. NAFCU and the entire credit union community appreciates this opportunity to participate in the discussion regarding the need for reform of the nation's bankruptcy system.

Nature of Credit Unions

Historically, credit unions have served a unique function in the delivery of financial services to people of modest means. Every credit union is, by statute and practice, a cooperative association organized "for the purpose of promoting thrift among its members and creating a source of credit for provident or productive purposes." [12 USC 1752(1)] While more than 60 years have passed since the

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Federal Credit Union Act was signed into law, two fundamental principles regarding the operation of credit unions remain every bit as important today as they were when Congress first authorized the establishment of federal credit unions:

• First, credit unions remain totally committed to providing their members with efficient, low-cost personal service.

• Second, credit unions continue to emphasize traditional cooperative values, such as democracy and volunteerism.

As owners of not-for-profit, cooperative financial institutions united by a common bond, all credit union members have an equal say in the operation of their credit union--regardless of the amount they have on account at the credit union. These singular rights extend all the way from making basic operating decisions to electing the board of directors. Unlike banks and thrifts, federal credit union directors, motivated by an altruistic desire to be of service to others, serve without remuneration--a fact that epitomizes the true "volunteer spirit" which permeates the credit union community.

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Credit unions play an important role in the financial lives of more than 70 million Americans from all walks of life who have chosen the convenient and low-

cost financial services that only credit unions can provide. As the package of services offered by various types of financial institutions becomes more and more homogenized, the emphasis shifts from the type of service offered to the quality and cost of service provided. Historically, credit unions have been second to none in providing their members with quality personalized service at the lowest possible cost. According to an annual survey conducted by the American Banker newspaper, 1997 was the thirteenth consecutive year in which credit unions have rated higher than all other financial institutions in overall service quality and this trend shows no sign of change.

Need For Bankruptcy Reform

Navy Federal Credit Union (Navy Federal) is the nation's largest credit union. Navy Federal serves civilian and military employees of the U.S. Department of the Navy and their families, serving almost 1.7 million members around the world through 84 branch offices, 183 proprietary ATMs, access to

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world-wide ATM networks, and "24 hour/365 day-a-year" telephone and internet service from its Vienna, Virginia headquarters and operations center. As with all

federal credit unions, Navy Federal is a not-for-profit cooperative, governed by a volunteer and unpaid board of directors who are elected by the credit union's member-owners. Navy Federal operates in the cooperative credit union spirit of "people helping people."

Unfortunately, a small but growing number of consumers are not financially responsible and abuse the bankruptcy system at a high cost to the consumers and the national economy. The credit union community feels strongly that bankruptcy reform is needed to encourage financial responsibility for debtors and for those creditors who would mislead or take advantage of consumers. The bankruptcy reform issue is not an issue of balancing the pursuits of debtors with the interests of creditors. It is simply an issue of financial responsibility versus financial irresponsibility.

The credit union community does not oppose bankruptcy relief for persons who have a bona fide need--those who have encountered extraordinary

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circumstances in life. Instead, the concern is with those consumers who use bankruptcy as a financial planning tool and those who turn to bankruptcy as the "easy way out."

For example, Navy Federal has a young member named Ruth who was living at home with her family. She incurred a few debts, one to Navy Federal, with her father as a cosigner. She decided to strike out on her own and moved to California where she ran into financial difficulty and was advised by her friends and an attorney to file for Chapter 7 bankruptcy relief. Navy Federal contacted the unsuspecting father who persuaded Ruth to consult the local Consumer Credit Counseling Service. After initial consultations with the counselors, Ruth withdrew her bankruptcy petition and repaid her debts through the counseling service's budget program. Because of the aid provided by Navy Federal, Ruth was able to avert ruining her credit rating and is able to obtain credit today.

Costs of Bankruptcy

Nationally, consumer bankruptcies have spiraled upward. Credit unions throughout the country have experienced a similar dramatic increase in consumer

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bankruptcy filings and losses in recent years (as indicated in Appendix A, Chart I). According to statistics compiled by NAFCU's Research Division, approximately $1.13 billion in loans were subject to bankruptcy at federally insured credit unions in 1997. That number is nearly double the amount subject to bankruptcy just three years earlier (Appendix A, Chart II). Over those three years the number of non-business bankruptcy filings grew at an average rate of 17 percent a year (Appendix A, Chart III). These numbers indicate a dangerous trend that must be addressed by Congressional action.

In recent years, Navy Federal has experienced a significant increase in members seeking relief through the bankruptcy courts. Each month, Navy Federal charges off $2 to $3 million in loans to bankrupt members. In 1997, Navy Federal's charge-offs to bankrupt members totaled $26 million--a figure up from $1.5 million 15 years ago, shortly after passage of the Bankruptcy Reform Act of 1978.

As with other credit unions, the costs of bankruptcy at Navy Federal must be borne by the financially responsible members of the credit union. In 1997, if

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Navy Federal had experienced no bankruptcy losses, consumer loan rates could have been reduced by more than one-half of 1 percentage point. Navy Federal's VISA Classic credit card rate, which is currently 12.5 percent with no annual fee, could have been reduced 1.3 percentage points. It is important to understand that

bankruptcy is anti-consumer in nature because responsible consumers pay the debts of the few who elect bankruptcy as a financial planning tool--encouraged by the advertising of unscrupulous attorneys or financial advisors. The seemingly quick "fix" of filing for bankruptcy is also harming young consumers as more and more are choosing it as an alternative. Once a young person chooses bankruptcy, he or she often has difficulty obtaining credit at reasonable rates from responsible financial institutions.

Credit Union Response to Bankruptcy

Most credit unions have lower operating margins than other types of lenders. Typically, credit unions pay higher rates on savings and charge lower rates on loans than other financial institutions. For example, Navy Federal currently pays 5 percent on its most popular share savings certificates, 7 percent

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on IRA share certificates, and charges 7.5 percent on the most popular auto loan. Because of these smaller margins, credit unions are hit harder than other financial institutions by escalating bankruptcy costs. A natural reaction for some institutions is to increase interest rates, but that is not what credit unions do. Credit unions keep interest rates as low as possible for the benefit of their members. At Navy Federal, the total loss ratio increased 129 percent over the last 15 years. But what is particularly significant is that while the non-bankruptcy loss ratio increased 35 percent, the bankruptcy loss ratio increased at a pace 7.5 times that rate: a staggering 264 percent.

Credit unions do much to promote financial responsibility among their members. Because credit union members pool their resources for the mutual benefit of all members, they have traditionally relied heavily on member education and individual counseling to encourage and promote financial responsibility. At Navy Federal, employees are trained in financial counseling. They assist with check book balancing and family budgeting. They advise members on the merits of saving and the consequences of heavy debt loads. Newsletter articles are published and brochures are provided for members to assist in making responsible

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financial decisions. Included in Appendix B are three examples of the brochures that Navy Federal publishes to assist its members with debt management and budgetary counseling. As one can see from the attached brochure, "Dollar Discipline Works!," Navy Federal attempts to educate all of its members on issues such as how to save money, how to borrow effectively and how to compute a monthly budget. All of these concepts are vital to an individuals ability to plan for a safe future.

In addition to member education and counseling activities, Navy Federal, like most credit unions, places an extremely high priority on sound underwriting practices. Navy Federal is continually upgrading and refining its underwriting techniques and tools. Automated tools are used in conjunction with traditional loan officer evaluations for all loans. Navy Federal attempts to reach those members with limited financial resources who truly need credit, by meticulously scrutinizing all applications. If an applicant's circumstances do not support the

requested amount, Navy Federal may offer to assist by countering with a lower debt limit offer that the member may be able to repay.

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Again, like most credit unions, Navy Federal does an excellent job of member education and loan underwriting, but at Navy Federal this is taken one step further. To illustrate, a young husband and wife, both in the military, and Navy Federal members, recently scheduled an appointment to seek legal advice for bankruptcy. Before the meeting, they received in their monthly statement from Navy Federal, a flier entitled "Bankruptcy, A Problem We All Share." As a result of reading the flier, they contacted Navy Federal's Budgetary Counseling Staff to see if there was an alternative to bankruptcy. We explained our intensive Budgetary Counseling and Debt Management Program and asked if the family wanted to participate. They agreed. We negotiated with other creditors for debt adjustments and lowered Navy Federal's payments. Except for essential family living expenses, they send all their income to Navy Federal. We actually pay their monthly bills and make their loan payments to other lenders. We are counseling this family on the wise use of credit and the responsible use of their financial resources. In a few months we will begin to return financial responsibility back to this family as they are, in fact learning to become financially responsible consumers. In 1997, almost 2,000 families of Navy Federal were assisted by this program.

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Members are charged nothing for this service even though the annual direct labor and supporting cost for this intensive Budgetary Counseling and Debt Management Program is approximately $700,000 excluding debt and interest adjustments. Often, interest is reduced or waived to enable members to continue making loan payments. Currently, over $3.2 million of Navy Federal's consumer loan and credit card portfolio accrues zero interest at an annual loss to the credit union of an additional $300,000. However, assisting members to become financially responsible is a sound investment of credit union resources; Navy Federal believes it is also a good example of creditor responsibility.

Reform Efforts: Credit Union Perspective

Because of the rising number of personal bankruptcy filings, the credit union community believes that legislative action is necessary to improve the current bankruptcy system. To support Congress in that effort NAFCU established an ad hoc Bankruptcy Committee. Only after extensive study, and bolstered with the input of a nationwide survey of credit unions, did NAFCU's ad hoc Bankruptcy Committee approve a formal "Proposal to Improve the Bankruptcy System." The product of a genuine effort to improve our nation's

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bankruptcy laws and procedures. A copy of this proposal is included as Appendix C).

To better understand how the nation's credit unions are affected by bankruptcy, NAFCU's ad hoc Bankruptcy Committee surveyed over 1,050 federally chartered credit unions (Appendix D for NAFCU Member Survey Responses). Approximately 97 percent of the respondents support a bankruptcy system that is needs-based. This would help to increase debtor accountability, create a fairer bankruptcy system, and more fairly distribute payments among all creditors. Debtor education was also viewed as critically important issue. Much like Navy Federal, most credit unions attempt to provide the best possible education for their members. Of those surveyed 84 percent support a requirement that would require debtors to participate in credit counseling before filing bankruptcy. Because of the current trends in bankruptcy filings and the views of all credit union members Navy Federal is pleased that attempts are being made to "reform" the current system. Reform is needed immediately as this problem grows and becomes more serious and widespread everyday.

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As reflected in NAFCU's proposal, credit unions throughout the country advocate meaningful reform of the bankruptcy system. NAFCU's proposal include recommendations that:

The Bankruptcy Code should require that debtors who are able to pay a portion of their debts file a repayment plan under Chapter 13;

The Code should establish uniform rules and procedures for processing creditors' claims and payments;

The Code should establish uniform federal exemptions;

Debtors should be required to complete a basic financial education course prior to receiving discharge;

A debtor should be required to notify secured creditors, within ten days of filing bankruptcy, whether the debtor intends to surrender, redeem, or reaffirm the collateral; and,

For creditors seeking to recover collateral, the automatic stay should expire at the end of the notification period.

NAFCU also recommends establishing a Bankruptcy Advisory Council, which includes debtor and creditor representatives. The council should be charged with studying bankruptcy and bankruptcy reform. This council could be established under the auspices of the U.S. Department of Justice. Alternatively,

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the Federal Reserve Board's existing Consumer Advisory Council should be required to submit an annual report to Congress on bankruptcy and bankruptcy reform.

Reform Efforts: Congressional Action

Despite all of the efforts to educate, to make sound loans, and to assist those in trouble, bankruptcy reform is needed and is needed now to encourage financial responsibility. The needs-based approach of H.R. 3150, the Bankruptcy Reform Act of 1998 introduced by Representatives George Gekas (R-Pennsylvania) and Jim Moran (D-Virginia), is a positive step towards helping to ensure more responsibility. H.R. 3150 would make a number of changes to U.S. bankruptcy law in an effort to prevent fraudulent bankruptcies and increase the likelihood that bankruptcy filers will repay their debts. NAFCU supports H.R. 3150.

NAFCU is pleased that H.R. 3150 stresses a needs-based system of bankruptcy. This would help in determining the correct amount of financial relief necessary. The Debtor's Bill of Rights provision should provide protection for debtors from "bankruptcy mills"--law firms and other groups that steer consumers

to bankruptcy. Other provisions of the Bankruptcy Reform Act of 1998 that will aid bankruptcy reform include: the creation of a consumer education program, debtor notification, and developing a national database.

Conclusion

Even before the National Bankruptcy Commission released its findings to Congress in October 1997, the need for overhaul of the nation's troubled bankruptcy system was evident. As bankruptcy filings increase, the burden on financial institutions also increases--a burden that ultimately is shouldered by the American consumer. We recognize the need for reform and are grateful that Congress is focused on the problem and is as determined as we to establish equitable reforms.

On behalf of NAFCU, thank you for considering the credit union perspective. We applaud your efforts and those of the Committee and hope to continue to work with you to resolve these and other challenging issues.

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